Author: danny; Source: X, @agintender

This article uses USDe’s plunge to $0.65 on CEX, but the on-chain price is 0.99 as an introduction, to analyze the local liquidation cascade risk caused by liquidity isolation in the crypto market, and to reveal the destructive power of liquidation robots on the market under the bottleneck of indiscriminate liquidation and deposit and withdrawal channels in the context of a liquidity vacuum.

This article intends to propose a circuit breaker mechanism algorithm based on composite quantitative indicators, using price deviation, order depth and large-scale liquidation exposure as triggering reference conditions.The circuit breaker mechanism is designed to provide the market with an n-minute adjustment window, allowing market makers to overcome operational frictions such as large withdrawals/recharges and on-chain congestion, and inject external liquidity.Ultimately, transactions are restarted through orderly call auctions to prevent the vicious cycle of liquidation, ensure the stability of the market structure, and alleviate and reduce the bad luck of exempting positions that do not need to be liquidated.

1. The fragmented structure of crypto market liquidity

1.1. Crypto Market Liquidity Map: CeFi, DeFi and Cross-Chain Isolation

The unique liquidity structure of the crypto asset market is the source of its endogenous risks.Liquidity is highly dispersed, spanning CEX, DEX and various types of DeFi.This kind of liquidity isolation has formed a fragmented ecosystem, and the friction between different liquidity pools (such as high on-chain transaction fees, complex cross-chain bridging time, and CEX’s review or locking mechanism for large deposits and withdrawals) has greatly hindered the free and rapid flow of capital.This structural friction is an important reason why the local liquidity crisis quickly worsens and cannot be repaired in time by arbitrage activities.

1.2. Market maker behavior and risk spillover in extreme market events

When the market fluctuates violently, liquidity providers (Market Makers) will quickly withdraw limit orders, causing the bid-ask spread (Bid-Ask Spread) to expand and the order book depth (Depth of Market) to drastically deplete.

When a liquidation cascade occurs, the liquidation engine and liquidation robot will trigger forced liquidation.These forced liquidations often take the form of large market orders and indiscriminate selling on order books with thin liquidity, further depressing prices.The failure of this market mechanism makes the price discovery process divorced from fundamentals and enters a self-reinforcing liquidation feedback loop.

1.3. Positioning of the circuit breaker mechanism: from passive suspension to active liquidity management

The core value of the circuit breaker mechanism is to provide an event window for active risk isolation and liquidity redistribution when market liquidity is vacuum.The essence of a circuit breaker is to temporarily suspend trading activity to prevent flash crashes driven by automated trading systems and panic from worsening amid a liquidity vacuum.

The circuit breaker mechanism is triggered by a precise algorithm to quickly isolate risks and establish a set of operating protocols to ensure that external capital can flow back into the market quickly and smoothly, thereby reestablishing liquidity depth when trading resumes.

2. USDe incident on October 11, 2025: Analysis of CEX partial liquidity failure

2.1 USDe price divergence between CEX and DEX: chain reaction caused by local failure

On October 10-11, 2025, the crypto market experienced the largest deleveraging event in history, with over $19 billion in leveraged positions liquidated in less than 24 hours.The destructive power of this violent market correction mainly comes from the high leverage of the market and the failure of the exchange’s risk mitigation mechanism.

According to public data, the timing of the market decline is as follows:

• 20:50 UTC, Oct 10: External shocks (such as tariff threats) trigger market turmoil and thin liquidity.

• 21:20 – 21:21 UTC, Oct 10: BTC and ETH prices fall to intraday lows as systemic selling peaks.

• 21:20 – 21:42 UTC, Oct 10: Ethena’s USDe begins to fall below $1 on the Binance spot market.

• After 21:36 UTC: A serious decoupling event occurs and the liquidation cascade begins to intensify.

• 21:42 – 21:51 UTC, Oct 10: USDe price bottoms out on Binance ($0.65), while other assets such as wBETH and BNSOL also see huge spreads against ETH and SOL.

A serious disconnect in cross-platform price discovery

On the Binance spot market, USDe briefly fell to $0.65, and Bybit also fell to $0.92.However, during the same period, in on-chain liquidity pools, such as the pool on Curve, the price of USDe remained near $0.99.Additionally, the Ethena protocol’s minting and redemption features have remained functional.

This huge price difference (nearly 35%) between CEX and DEX reveals the nature of the problem: this is not a fundamental decoupling of the USDe asset itself, but a partial failure of CEX’s internal pricing mechanism.When the liquidation cascade opens, order book liquidity is quickly drained.Exchanges like Binance rely on their internal spot market prices to estimate collateral value.When the depth of the internal spot market is insufficient, small transaction shocks can cause severe price distortions, causing the clearing engine to incorrectly assess the value of USDe (and other linked assets such as wBETH) as collateral.This mispricing resulted in unnecessary liquidations, adding fuel to the fire to the liquidation engine that further pushed the price down to $0.65.

2.2 What hinders mobility: time, network and operational barriers

In periods of extreme volatility, arbitrage behavior faces multiple “channel bottlenecks”, making it impossible for liquidity to be moved back into the market from the outside in a timely manner.

1. Settlement times and network congestion: During periods of extreme market activity, blockchain networks often experience high transaction volumes, causing network congestion.This makes transaction confirmation times longer and gas fees soar.

2. CEX operation lock: CEX’s restrictions and audits on large deposits and withdrawals prevent market makers from injecting this external liquidity into the market during the window period that requires minute-level response.

The circuit breaker mechanism is precisely designed to provide a time window long enough to resolve these technical, operational and risk control obstacles in extreme market environments – providing a breathing channel for liquidity.

This is like temporarily inserting a catheter (connecting to off-site mobility) to a patient with a pneumothorax (fluid vacuum) to remove the excess air (clearing energy) so that the patient can push through.

3. Design of circuit breaker trigger algorithm: composite quantitative indicators

In order to cope with the high frequency and decentralized characteristics unique to the crypto market, the circuit breaker trigger mechanism must exceed a single index drop threshold in traditional finance.A single, linear price trigger mechanism is easily predicted and manipulated by high-frequency traders, leading to a “Magnet Effect” when approaching the threshold, in which traders accelerate transactions to avoid being suspended from trading, which in turn intensifies the market volatility before the trigger.

This article proposes a circuit breaker algorithm for a composite quantitative indicator, which contains three core dimensions: price deviation, liquidity impact and transaction speed.Only when these three indicators trigger the preset thresholds at the same time or within a very short period of time, the system will activate the circuit breaker alarm.

3.1. Indicator 1: Cross-platform reference price deviation (CVD) and its index construction

Introduce a multi-source weighted aggregate price index based on multiple high liquidity as a reference price to resist the internal pricing failure of a single CEX.

CVD = |Price_CEX – Price_Index| / Price_Index * 100%

The first condition for a circuit breaker is an unsustainable deviation between the spot price on the market and the reference price index:

Quantitative threshold: Considering that pegged assets such as USDe should be tightly anchored under normal circumstances (<0.1% deviation), when the price difference exceeds the range that can be explained by arbitrage costs, transaction delays, and on-chain capital pools, a circuit breaker alarm should be issued.

• Recommended threshold: Set the cross-platform reference price deviation CVD > 3%.

• Empirical significance: In the 10.11 incident, when USDe fell below $0.97 on Binance, the circuit breaker alarm was triggered, well before it fell to the bottom of $0.65, effectively isolating the risk.

3.2. Indicator 2: Order book depth and liquidity shock (DOM/Slippage Shock)

Price changes are the result, liquidity depletion is the cause of structural failure.Therefore, circuit breakers must directly monitor the health of the order book.

Order Book Depth Ratio R_L: Measures the ratio of the cumulative tradable quantity Q_Current within a specific price range (e.g., deviation from the current price delta = 1%) to the asset’s Q_Benchmark during past quiet periods (e.g., the median depth over the past 30 days).

R_L = Q_Current / Q_Benchmark

trigger threshold: R_L < 20%, that is, the order book depth is depleted by more than 80% compared to the normal level.

Slippage Impact S_I: This is a more intuitive liquidity vacuum indicator.It is defined as the expected price slippage percentage resulting from executing a market order of preset notional value V (e.g. V=$1M USD).

S_I = (P_Executed – P_Mid) / P_Mid * 100%

Among them, P_Mid is the twap transaction price, and P_Executed is the final price after the V order is executed.When liquidity is abundant, S_I is extremely low; when the order book is drained, S_I will increase sharply.

• trigger threshold: Setting S_I > 5% indicates that when executing a medium-sized trade, the market will immediately experience sharp slippage, reflecting a liquidity vacuum.

3.3. Indicator 3: Transaction speed and liquidation risk exposure

In addition to the above structural indicators, the circuit breaker mechanism also needs to include an indicator of large-scale liquidation exposure.

Price Velocity V_P: Monitor the extremely rapid rate of change of asset prices within a very short time window (such as 5 minutes).

• trigger threshold: Similar to the circuit breaker design of the securities market, such as V_P > 10% drop.

Liquidation Exposure (LCE): Combining price velocity V_P with open interest OI data, estimate the distance to the next large-scale liquidation cluster (Liquidation Cluster).When LCE exceeds a preset threshold, indicating that the market is on the verge of a liquidation cascade, circuit breakers should be triggered to prevent system collapse, even if price deviations and deep exhaustion have not yet reached extreme values.

fuse trigger condition:

The circuit breaker will be triggered only when the cross-platform reference price deviation and the order book depth ratio meet the warning conditions at the same time, or when the price speed, slippage impact, and liquidation risk exposure reach the threshold at the same time.

4. Operations during the circuit breaker phase: liquidity injection and risk isolation

Once the circuit breaker algorithm is triggered, the market enters a pause state for N minutes.The success of this stage depends entirely on whether exchanges and market makers can eliminate channel bottlenecks for liquidity replenishment and risk control measures during this period.

4.1. Dynamic calibration model of fuse window N

The circuit breaker window N must be set to overcome the longest and most critical liquidity transfer friction.

N = max (T_DLP, T_On-chain_Priority) + T_Buffer

Among them:

• Tl_DLP: The longest time it takes for a market maker to transfer funds from its own over-the-counter capital pool to CEX’s internal account (which may involve cross-CEX or fiat currency withdrawal locking processes).

• T_On-chain_Priority: The fastest confirmation time required for on-chain transfers (such as moving stablecoins in a DEX to a CEX address) under congestion conditions by paying high-priority gas fees.

• T_Buffer: Additional buffer time for information digestion and recalibration of the MM risk control system.

The circuit breaker mechanism must rely on two emergency capital injection channels:

1. Pre-escrow external cold wallet funds: Circuit breaker N must cover the time when CEX is transferred from the cold wallet to the hot wallet and allocated to the MM account.

2. High-speed, high-priority on-chain transfers: Fusing N must cover the fast confirmation time (usually a few minutes to ten minutes) under extremely high gas costs.

Actual calibration: Considering that emergency capital injection requires manual intervention and decision-making time from the MM team, as well as network congestion and internal processing queues, it is recommended to set N in the range of 5 to 10 minutes to ensure that market makers have a reasonable time window to execute their emergency capital injection process.

4.2. Priority Funding Agreement for Designated Liquidity Providers (DLP)

During the circuit breaker period, exchanges must activate an OTC capital injection channel protocol (Out-of-Band Capital Protocol, OBCP) exclusively for use by Designated Liquidity Providers (DLPs).

1. DLP Certifications and Qualifications: Exchanges must pre-screen and certify institutions with sufficient OTC emergency liquidity as DLPs.

2. OBCP channel: Establish a dedicated, high-priority API interface or internal liquidation process to allow DLP to submit large stable currency deposits during the circuit breaker period.These top-ups must be immediately credited to DLP’s internal trading account and bypass the withdrawal locks, queuing and review procedures faced by standard users.

3. Pre-submission of orders during the circuit breaker period: During the circuit breaker suspension period, all market orders are cancelled.But DLP and other authorized participants are allowed to submit new limit orders.These orders will not be executed during the pause, but will instead be entered into the order book when trading resumes as a willingness and basis for liquidity to return.This ensures that when the market restarts, the order book can immediately regain depth and avoid price gaps.

4.3. Risk isolation and liquidation suspension mechanism

After the circuit breaker is triggered, the following risk isolation measures must be implemented immediately:

1. Full suspension of liquidation: All margin calls and forced liquidation operations of the liquidation engine must be stopped immediately.The fundamental goal of circuit breaker is to prevent the self-reinforcing cycle of liquidation cascades.

2. Collateral value locked: During the suspension period, the collateral price used to calculate margin positions (such as USDe in the 10.11 incident) must be locked at the last valid reference price before the circuit breaker was triggered.This prevents collateral values ​​from collapsing further due to market microstructural failures, thus protecting users from unnecessary liquidation risk.

5. Transaction recovery mechanism: quantitative security standards and orderly restart

The end of the circuit breaker should not depend on a predetermined time, but on whether liquidity returns to normal.If the market rashly restarts when liquidity has not yet been restored, it may lead to a larger price gap and a second panic.

5.1. Quantitative prerequisites for resumption of trading

A prerequisite for the circuit breaker to be lifted is that order book depth and cross-platform price discovery mechanisms return to healthy levels.The system needs to continue to monitor the following indicators after the N-minute circuit breaker window ends until they meet the recovery criteria:

a. Convergence of Price Differences (CVD): Cross-platform spreads must converge to a level close to the arbitrage limit.

• Recovery Criteria 1: CVD < 1%.This shows that the on-site price has been highly consistent with the external reference index, and the problem of local pricing distortion has been resolved.

b. Deep recovery (R_L): Order book depth must be sufficient to absorb large trades and prevent slippage immediately upon recovery.

• Recovery criterion 2: R_L > 50%.This means that the cumulative depth of the order book in the plus or minus 1% range must return to at least half of the median level in normal times.Below this threshold, resumption of trading will be subject to significant execution risk.

c. Reduced liquidation risk: Assess whether the liquidation risk exposure LCE has dropped to a safe level, indicating that leverage has been effectively de-levered.

5.2. Phased and orderly restart process: silent period and collective bidding

To prevent chaos and price gaps when trading resumes, exchanges should adopt an orderly, phased restart mechanism similar to the call auction process in traditional financial markets.

Phase I: Cool-down Period

• Duration: 2-5 minutes.

• Action: Cancel all remaining market orders.Market participants, particularly market makers, are allowed to submit new limit orders or modify limit orders that had been submitted before the suspension.Market information (such as the total depth of unfilled orders and the latest reference price) should be widely disseminated, but orders are not executed.

Phase II: Auction Period

• Duration: 2-5 minutes.

• Action: The system collects all orders submitted during the quiet period and circuit breaker period.An equilibrium price discovery algorithm is used to calculate the single equilibrium price that maximizes trading volume during this set period.All orders executed at the best price will be matched and executed at this equilibrium price.The call auction ensures transparency in price discovery and leverages the liquidity injected by DLP during the pause to establish a stable initial price.

Stage III: Continuous Trading

• Action: Resume normal trading.All remaining limit orders (those not executed in the auction) are entered into the order book, and the market returns to continuous matching mode.

Just like a craniotomy, suturing the opening is just the end of a phase, and there are subsequent reconstruction, examinations and rest.

6. Some sleep talking

The circuit breaker mechanism actively compensates for the systemic vulnerability caused by liquidity isolation and operational friction during the period of violent fluctuations in the crypto market by introducing a time isolation window (N minutes).The USDe incident on October 11, 2025 clearly demonstrated that when the liquidation cascade is superimposed on the on-site liquidity vacuum, even assets with a sound on-chain redemption mechanism may have catastrophic consequences due to local mispricing of CEX.

The core design of this mechanism is:

1. Composite trigger algorithm: Avoid the “magnet effect” caused by a single price trigger, and use composite indicators of price deviation, order book depth and slippage impact to accurately capture the collapse of the market microstructure.

2. Dynamic circuit breaker duration: N must be set with the goal of overcoming the “channel bottleneck” of market makers’ capital injection, especially to deal with operational/technical obstacles such as CEX deposit and withdrawal restrictions, risk control strategy optimization, and on-chain network congestion.

3. orderly recovery agreement: Introduce a silent period and call auction, and use quantitative indicators of liquidity return as a necessary condition for resuming trading to ensure that the market restart is stable and in-depth.

As the DeFi ecosystem matures, the systemic risks of cross-chain and decentralized protocols are also increasing.The concept of circuit breakers can be extended to the DeFi field, for example:

• In automated market maker (AMM) pools, protocol-level trading pauses can be triggered when depth drops sharply such that expected slippage on executing trades of a specific size exceeds a critical threshold.

• DeFi protocols can use their governance mechanisms to make parameter adjustments during the circuit breaker period, such as temporarily increasing lending rates, adjusting liquidation thresholds, or allowing liquidity providers (LPs) to inject or withdraw liquidity within a safe price range, thereby optimizing their liquidity provision strategy under random control.(Some lending protocols currently have similar operations)

The fuse mechanism is not a panacea. At best, it is just a pulse defibrillation, a shot of adrenaline, and a shot of intubation, just to buy you time to get to the door of the emergency room.